Public Policy Brief CRISIS, AUSTERITY, AND FISCAL EXPENDITURE IN GREECE: RECENT EXPERIENCE AND FUTURE PROSPECTS IN THE POST-COVID-19 ERA - Levy ...
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Levy Economics Institute of Bard College
Levy Economics
Institute
of Bard College
Public Policy Brief
No. 151, 2020
CRISIS, AUSTERITY, AND FISCAL
EXPENDITURE IN GREECE: RECENT
EXPERIENCE AND FUTURE PROSPECTS
IN THE POST-COVID-19 ERA
michalis nikiforosContents
3 Preface
Dimitri B. Papadimitriou
4 Crisis, Austerity, and Fiscal Expenditure in Greece: Recent Experience and Future Prospects
in the Post-Covid-19 Era
Michalis Nikiforos
15 About the Author
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ISSN 1063-5297
ISBN 978-1-936192-67-0Preface
In this policy brief, Michalis Nikiforos provides a discussion of the it. Austerity was imposed in the name of debt sustainability. However,
relationships between austerity, Greece’s macroeconomic perfor- this generated a vicious cycle of recession and austerity, as each
mance, debt sustainability, and the provision of healthcare and other round of austerity measures led to slower GDP growth, which in turn
social services over the last decade. increased the debt-to-GDP ratio—therefore undermining the goal of
Through drastic cuts to public expenditure and a nearly 10 per- debt sustainability and leading to yet another round of austerity.
centage point increase in the average tax rate (if one includes social In this context, the Greek government’s creation of primary bud-
contributions), the Greek government hit the primary budget surplus get surpluses represented a titanic effort. As Nikiforos emphasizes,
targets that were set out as a condition of receiving financial assistance. budget deficits are usually countercyclical, rising in slumps and shrink-
A key part of these escalating rounds of austerity policies was sig- ing in upturns. That is, given that austerity drove growth down, which
nificant reductions in healthcare expenditure. As Nikiforos observes, further worsened the fiscal position, hitting fiscal targets required far
healthcare spending was cut nearly in half between 2009 and 2014— deeper cuts and tax increases to deal with the second-order budgetary
and Greece was already (prior to these cuts) below the EU average in damage resulting from prior rounds of austerity.
terms of healthcare spending as a percentage of GDP. Although health Ultimately, Nikiforos concludes, Greece’s public debt is unsus-
expenditures have recovered slowly since 2014, in 2018 they were still tainable and a major restructuring is needed. In his view, this was
down 42 percent from their 2009 level. The result was a drastic deteri- true before the pandemic. With the COVID-19 crisis, we are well
oration in the quantity and quality of healthcare coverage—including beyond minor deviations from an overly optimistic baseline projec-
significant attrition in hospital bed capacity. In addition to the erosion tion. The pandemic shock will lead to a rapidly rising public debt
of economic and social rights due to austerity in general, Nikiforos ratio. The pandemic thus places two pressure points on the austerity
points out that the healthcare cuts in particular weakened Greece’s strategy imposed on Greece. As mentioned, the depleted healthcare
ability to handle the COVID-19 pandemic. capacity undermines their ability to contain and treat the virus’s
According to the international and European institutions spread. And as debt and deficits rise due to the economic fallout
providing assistance, the justification for imposing these austerity from the pandemic, deeper and deeper cuts will be required if the
policies—including undermining healthcare capacity from 2009 austerity strategy is not abandoned—further crippling not only the
to 2014—was that Greece’s public debt would thereby be rendered country’s general ability to deal with a downturn using fiscal policy,
sustainable. Nikiforos explains that the standard of “sustainability” but also the healthcare system’s already-weakened capacity to man-
was twofold: (1) a stable or declining trajectory for the debt-to-GDP age the pandemic.
ratio, and (2) gross financing needs (the sum of the budget deficit Moreover, as Nikiforos observes, this coronavirus crisis will not
and the funds necessary to roll over maturing debt in a given year) impact Greece alone. Other vulnerable eurozone countries will see
not exceeding 20 percent of GDP. their public finances deteriorate severely enough to require finan-
However, the European Commission’s analyses of the sustain- cial assistance from the European Stability Mechanism—assistance
ability of the Greek public debt were flawed—rooted in optimistic whose prerequisites are conditionalities that will launch these coun-
baseline projections and an unwavering assumption of a return to a tries into the cycle of austerity, recession, and deeper austerity that
healthy growth trend in the medium run (the latter being the result Greece experienced. To avoid this outcome—one which Nikiforos
of a commitment to macroeconomic models in which fiscal policy believes may hasten the breakup of the eurozone—he advocates at
changes have only short-term effects and the economy bounces back least limited debt mutualization (with respect to the debt increases
to its “natural” growth rate in the medium term). Nikiforos explains, certain to result from the pandemic) and the issuance of a common
however, that even slight deviations from these baseline assumptions bond, along with policies to finally address the structural imbalances
would cause Greece’s public debt to be become unsustainable. within the euro area.
As it turned out, Greece’s actual growth rate has been consis- As always, I welcome your comments.
tently below the rates forecast by its international lenders, resulting in
a public debt ratio that has been well above lenders’ projections (even Dimitri B. Papadimitriou, President
despite the 2012 debt restructuring). The problem is that the fiscal June 2020
targets were incompatible with the growth targets, as Nikiforos puts
Levy Economics Institute of Bard College 3Introduction In the COVID-19 era, the implications of this conclusion
A first draft of this policy brief was written in the fall of 2019 are very important. If even a small shock would make Greek
to provide some macroeconomic background for a report by debt unsustainable, the pandemic shock will definitely do so.
Amnesty International on the effects of austerity on basic eco- Hence, sooner rather than later, Greece and the eurozone will
nomic and social rights in Greece, with an emphasis on health- face the same questions that were swept under the rug in the
care provision (Amnesty International 2020). My plan was to past decade.
revise the original manuscript and publish it at some point in There are three important differences compared to ten
the spring. years ago. The first obvious one is that after having already
In the meantime, the COVID-19 shock hit econo- lost a quarter of its output, the support for austerity policies
mies around the world, including the Greek economy. In of a similar magnitude will be considerably weaker this time
fact, according to some recent Organisation for Economic around. Second, and related to the first difference, the COVID-
Co-operation and Development (OECD 2020) estimates, the 19 shock itself demonstrates that public functions such as
Greek economy faces the most severe potential initial impact healthcare provision are essential. Hence, it will also be harder
due to the partial or complete shutdowns related to the pan- to justify further cuts in government expenditure, especially
demic, in comparison to a relatively broad group of selected for these functions. Third, the problem this time will not con-
advanced and emerging market economies. The International cern Greece alone. Due to the COVID shock, several European
Monetary Fund (IMF 2020a), in its April 2020 World Economic economies will face issues with their public—and private—
Outlook, is projecting that the growth rate of the Greek econ- indebtedness when the dust settles.
omy for 2020 will reach -10 percent. Hence, the moment of truth—for Greece and for the
The pandemic shock made this policy brief—and of eurozone more broadly—has come. The effect of the pan-
course the Amnesty International report—even more timely demic in every single member country will be an increase in
than before. It is now widely acknowledged that a robust public private and public debt-to-GDP ratios. In the most vulner-
healthcare system is key to fighting the pandemic. The health- able economies these ratios will most likely exceed what the
care sector employees who are now hailed as national heroes markets consider acceptable. So a likely scenario for the com-
were, until only very recently, slandered by the architects of the ing years is that several countries will have to resort to fund-
austerity and adjustment programs as one of the main exam- ing from the European Stability Mechanism, which is tied to
ples of corruption in the Greek public sector. conditionalities and adjustment programs like those imposed
Therefore, it is important to understand what effects on Greece. If the eurozone follows this path, the most likely
the austerity of the last ten years had on public healthcare in outcome is a breakup that will follow in the next few years.
Greece, and how the healthcare expenditure cuts were justified To avert this, eurozone countries will have to agree to some
in the name of public debt sustainability. measures and policies that until now seemed unrealistic. At
The first draft of this policy brief also included a sec- a minimum, there is a need for a mutualization of the debt
tion on the dangers for the Greek public healthcare sector in related to the pandemic, with the issuance of a common bond.
adhering to the future commitments required by the adjust- In the medium run, it is also necessary to enhance the fiscal
ment programs. The point I was making was that, according capacity of the Union, and to design regional policies that will
to the various debt sustainability analyses performed by the address the structural imbalances among countries. In the case
European Commission (e.g., 2018), Greek public debt was of Greece, in addition to these measures, a bold restructuring
deemed sustainable under some optimistic baseline assump- of the debt will be necessary.
tions; however, even very small deviations from these assump-
tions would lead to an explosion of the debt-to-income ratio.
Hence, I concluded, given the experience of the previous Some Basic Indicators
period, this poses great risks for the provision of healthcare In the period after the Great Recession of 2007–9, the Greek
and other public services. economy experienced the largest drop in real output that any
currently advanced economy has experienced in peacetime.
Public Policy Brief, No. 151 4Figure 1 shows that by 2013, Greece had lost 23 percent of her government expenditure was 30 percent below its 2009 level.
output compared to 2009 (when the crisis started, after the Meanwhile, as Figure 2b shows, the implicit average tax rate
October elections of that year). Compared to 2007, which was (including social contributions) increased by 10 percentage
the peak of the previous cycle, the decline was close to 27 per- points compared to the precrisis period.
cent. In the same figure we can also see that the period that The expenditure cuts were across the board. Figure 3
followed the freefall of 2009–13 was one of anemic growth. As shows that among the different categories of public expendi-
of 2019, real GDP was only 5.5 percent above its level from six ture, only expenditure on environmental protection increased
years earlier. in the 2009–18 period. The remaining categories have seen
As one would expect, unemployment increased. At its peak sharp decreases; expenditure on social protection, which is
in 2013 it reached 27.5 percent, almost 20 percentage points proportionally the largest category, decreased by a below-aver-
above its 2008 level. Due to the stabilization of the economy, age 18.5 percent. This is normal, given the high unemployment
the unemployment rate has decreased and in 2018 fell below rates of the period.1 On the other hand, the next two biggest
20 percent for the first time since the crisis began. This decline categories—general public services and health—have seen
is to a certain extent due to the migration of a significant part above-average cuts of 45 percent and 42 percent, respectively.2
of the labor force—the most educated and productive part—
abroad, mainly to northern Europe and the United States.
Moreover, and not unexpectedly, the crisis had severe con-
sequences for social conditions in Greece. According to data Figure 1 Index of Real GDP 2000–20 (2009=100)
from the European Union Statistics on Income and Living
110
Conditions (EU-SILC), the number of people at risk of poverty
105
or social exclusion increased rapidly between 2010 and 2013— 100
by more than 900,000 in only three years, out of a total popula- 95
tion of around 11 million. 90
The Greek crisis started as a fiscal crisis when, after the 85
80
elections in October 2009, it was announced that the fiscal
75
deficit would be roughly double what was previously projected. 70
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
At the heart of the crisis, then, was an effort to consolidate the
budget. The drop in output reported in Figure 1 was accom-
Source: AMECO
panied by severe austerity. Figure 2a shows that by 2016, real
Note: The number for 2020 assumes a drop in GDP of 10 percent.
Figure 2 Government Expenditure and Taxes
(a) Index of real government expenditure (2009=100) (b) Total tax burden including imputed social security contributions (% GDP )
105 44
100 42
95 40
90
38
85
36
80
34
75
70 32
65 30
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
2019
Including Interest Excluding Interest
Source: AMECO
Levy Economics Institute of Bard College 5Figure 3 Percentage Decrease in Government Expenditure The burden of the cuts in healthcare naturally fell on the
by Function, 2009–18 biggest categories of healthcare expenditure: “hospital ser-
60 vices” and “medical products, appliances, and equipment.” In
50
2009, they comprised 62 percent and 32 percent of total health-
40
30
care expenditure, respectively. Figure 4b shows that the former
20 has been cut by 43 percent and the latter by 55 percent. On
10 the other hand, minor categories such as “outpatient services”
0
and “R&D health” (around 4 percent and 0.2 percent of total
-10
-20 healthcare expenditure in 2009) have seen an increase.
-30 Figure 5 presents a comparison of government health-
n
n
n
e
s
h
s
ty
on
ies
tal
care expenditure in Greece and other European Union (EU)
ice
nc
air
tio
tio
tio
alt
afe
To
nit
igi
efe
erv
aff
He
ca
tec
tec
ds
rel
me
u
D
countries. Before the crisis, Greece was already below the EU
cs
ro
o
ic
Ed
an
pr
om
nd
lp
ya
li
ub
tal
er
ea
cia
nit
on
average. Because of the cuts of the previous years, government
rd
p
en
ur
So
Ec
mu
ral
co
nm
ult
ne
healthcare expenditure is now around 5 percent of GDP—on
om
bli
,c
o
Ge
vir
Pu
dc
on
En
the same level as other EU countries that were subjected to aus-
ati
an
cre
ing
terity programs and applied the cuts (like Ireland), or Eastern
Re
us
Ho
Source: Eurostat
European countries where healthcare expenditure was quite
low to begin with (such as Bulgaria, Romania, and Estonia).
Figure 5 also reveals that, at least in the European context,
Public Healthcare public expenditure on healthcare increases with a country’s
Sharp decreases in healthcare expenditure are a staple of aus- per capita income and level of development. Seen from that
terity programs where the IMF is involved, because it is a sector point of view, one of the results of the austerity policies was
where cuts can be applied quickly. In fact, Figure 3 presents to push the countries where it was implemented backwards
only one aspect of the story. As Figure 4a shows, the cuts in real toward earlier stages of economic development.
government expenditure on healthcare approached 47 percent In recent work, Temin (2018) and Storm (2017) use the
by 2014, and then slowly recovered in the following years. distinction between “dual” and “mature” economies that
In other words, real government expenditure on healthcare was originally proposed by Lewis (1954). They argue that the
almost halved within a five-year period. political and economic developments of the last four decades
Figure 4 Government Healthcare Expenditure
(a) Index of real total government expenditure (2009=100) (b) Percentage decrease in government healthcare expenditure
by function (2009–18)
80
100
60
40
90
20
0
80
-20
-40
70
-60
-80
60
-100
-120
50
-140
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Total Medical Outpatient Hospital R&D Health
products services services health n.e.c.
Source: Eurostat
Public Policy Brief, No. 151 6Figure 5 Government Expenditure on Healthcare for Various European Union Countries (percent of GDP)
10
9
8
7
6
5
4
3
2
tia
Ire ia
ain
Li via
Bu m
Cz ia
D chia
m ia
ce
Po ia
Ge ark
us
Cr e
Cy y
he lta
Es y
Sl nia
y
m
28
Fi ia
Sl ia
ni Sw nd
s
Be 19
d
ng n
Po nd
ry
H urg
Ro gal
c
l
an
wa
nd
n
ar
xe an
str
Ita
lan
iu
d ede
ee
ak
an
an
pr
oa
do
a
ga
EU
t
EA
to
Sp
a
m
la
e
La
lg
N M
rm
rtu
lg
e
r la
Lu thu
bo
or
Gr
nl
Au
ov
ov
Fr
m
un
en
N
Ki
et
te
U
2009 2018
Source: Eurostat
have led to the reversion of the US economy to a “dual” econ- Figure 6 Hospital Beds per 100,000 Inhabitants
omy, with only a fraction of the population having access to
500
education, healthcare, and enjoying the benefits of economic 490
growth. The austerity policies in the European periphery have 480
also led to a fast-track dualization of its respective economies 470
460
and societies—thus achieving in only a few years what took
450
four decades of slow change in the United States. Figure 5 also 440
gives a glimpse of this process. 430
A detailed discussion of the effects of this precipitous cut 420
410
in expenditure on healthcare is beyond the scope of this pol-
06
07
08
09
10
11
12
13
14
15
16
17
20
20
20
20
20
20
20
20
20
20
20
20
icy brief (the aforementioned report by Amnesty International
Source: Eurostat
[2020] provides such a discussion, and the interested reader can
refer to that). Two comments are sufficient here. First, as one
can easily imagine, halving government expenditure on health- The “Logic” of Austerity
care in only five years led to an equally dramatic decrease in the The political economy of fiscal austerity is a very interesting
quality and quantity of healthcare coverage. Second, these cuts topic; it is, however, beyond the scope of this policy brief. One
had an obvious effect on the ability of the Greek healthcare sys- aspect is important for our purposes. When a country finds
tem to cope with the recent COVID-19 pandemic. One metric of itself in the position to ask for external financial assistance—
this ability, to which many commentators have recently referred, from the IMF or from European institutions—austerity is jus-
is hospital bed capacity. As Figure 6 shows, the austerity and the tified in the name of the sustainability of public finances.
decrease in expenditure on “hospital services” led—unsurpris- If a country’s debt burden is unsustainable, then the gov-
ingly—to a rapid decrease in the number of hospital beds. The ernment will not be able to repay whatever funds it borrows.
figure shows that the Greek healthcare system lost roughly 14 For that reason, the IMF has an explicit policy not to lend to
percent of its bed capacity within five years. Almost half of the a government with unsustainable debt, unless there are addi-
decrease took place in the very first round of austerity in 2010. tional measures (such as debt restructuring) that bring about
Levy Economics Institute of Bard College 7this sustainability. The European institutions do not have such This discussion makes clear the “logic” of austerity, as it
an explicit clause, but it would be political suicide to admit that was stated in the various memoranda and reviews of the three
they are lending funds that will never get repaid. adjustment programs. Austerity—the cuts in government
In turn, assessing debt sustainability is a difficult issue, expenditure and the increase in tax rates (see Figures 2 and
and different measures have been proposed (for a recent dis- 3)—will lead to a decrease in the government deficit (or an
cussion, see Corsetti [2018]). The most common one, especially increase in the surplus) and therefore will have a direct positive
for medium- and long-run analyses, is the public-debt-to-GDP effect on debt sustainability. Additionally, the various “struc-
ratio. A country’s debt is considered sustainable if the ratio tural reforms” will boost the growth rate and also contribute
tends to stabilize or decrease in the medium run; it is consid- to debt sustainability. It was recognized that inflation might
ered unsustainable if the ratio keeps increasing (or “explodes” fall, but this would have a positive effect on competitiveness
in economic jargon). and growth that would be larger than the negative direct effect.
There are five main factors that determine the debt-to- Finally, by providing loans with interest rates below the mar-
income ratio’s trajectory: (1) the primary surplus, (2) the growth ket rate, the adjustment programs would also contribute to the
rate, (3) the interest rate, (4) the inflation rate, and (5) the level sustainability of public finances.
of the debt-to-income ratio itself. All other things equal, an For example, the first memorandum, signed in May 2010,
increase in the primary surplus, the growth rate, or the inflation predicted a very fast fiscal consolidation: namely, a 12 percent-
rate would tend to decrease the debt-to-income ratio. Conversely, age point improvement in the primary deficit by 2013. This
an increase in the interest rate and a high level of the ratio itself fiscal adjustment was projected to be accompanied by a rela-
tend to increase and destabilize it. tively shallow recession and a fast return to growth in 2012.
In mathematical terms, the trajectory of public debt as a Together with the proceeds of privatization of public assets,
percentage of GDP can be described by the following equation: the forecasted trajectories of these basic macroeconomic vari-
p ables (deficit, growth, inflation rate) were supposed to lead to
Δ(D/PY)t = [d t +(jt - gt - πt - πt gt)Dt -1)]/Pt Yt (1)
a containment of the debt–income ratio, which would, accord-
where Δ is the difference operator, D stands for government ing to the projection, reach 150 percent in 2013 and decrease
p
debt, P for the real GDP, Y for the price level, d for the primary thereafter.
deficit, j for the interest rate, g for the real GDP growth rate, π
for the inflation rate, and the subscript t for the time period to
which each variable refers. The Vicious Cycle of Recession and Austerity
The intuition behind this equation is straightforward. An Things turned out differently. The original projections—and
increase in the growth rates of income and inflation tend to the projections after them—proved to be wildly optimistic.
increase the denominator of the debt–income ratio (and thus Figure 7 presents the projections made in the three memoranda
decrease the ratio itself). An increase in the primary surplus and intermittent reviews, contrasted with the Greek economy’s
means more savings and therefore a decrease in the stock of actual GDP growth rate, for the years 2010 to 2018.3 It becomes
debt in the ratio’s numerator. Finally, an increase in the interest immediately clear that the actual growth rate has been consis-
rate and a high level of debt burden imply a high level of inter- tently below what the international lenders were forecasting.
est payments, which tend to decrease savings and increase the The growth rate reached -9.13 percent in 2011 (as opposed to
debt–income ratio. the -2.6 percent rate forecasted in May 2010 or the -3.8 percent
Equation (1) was first used by Domar (1944) in an analysis rate forecasted in July 2011).4
of “the burden of debt” and national income of the US econ- Another interesting observation one can make in relation
omy after the war. It is a simple stock-flow accounting identity, to Figure 7 is that, despite the successive forecasting errors,
and therefore it is true by definition, and applies to the analy- the medium-term projections remained unchanged for a long
sis of the debt–income ratio of any sector or agent. Hall and period of time. In all these projections, the economy is bound
Sargent (2011, 193) have called it the “least controversial equa- to return to an “equilibrium” growth rate of between 2 percent
tion of macroeconomics.”
Public Policy Brief, No. 151 8Figure 7 Actual and Projected Growth Rate, 2007–18 Figure 8 Actual and Projected Real GDP, 2007–18
6 105
4 100
2 95
90
0
85
-2
80
-4 75
-6 70
-8 65
-10 60
07
08
09
10
11
12
13
14
15
16
17
18
07
08
09
10
11
12
13
14
15
16
17
18
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
May-10 Feb-11 Jul-11 Mar-12 May-13 May-10 Feb-11 Jul-11 Mar-12 May-13
Apr-14 Aug-15 May-17 Mar-18 Actual Apr-14 Aug-15 May-17 Mar-18 Actual
Source: AMECO; European Commission; author’s calculations Source: AMECO; European Commission; author’s calculations
and 3 percent in the medium run, which is independent of Figure 9 Actual and Projected Government Debt-to-GDP
what is happening in the near term. Ratio, 2007–18 (percent of GDP)
The same sort of overoptimism—albeit with a smaller 200
margin of error—has been common in the forecasts made by
180
the IMF, the European Commission, and other official agencies
160
(like the US Congressional Budget Office) for most European
economies in the period after the recession.5 In other words, 140
the conventional wisdom for many years after the crisis was 120
that the economies would bounce back and return to their pre-
100
crisis rates of growth.6
07
08
09
10
11
12
13
14
15
16
17
18
20
20
20
20
20
20
20
20
20
20
20
20
These errors are telling. The implicit assumption being
May-10 Feb-11 Jul-11 Mar-12 May-13
made is that fiscal policy or monetary and financial factors can
Apr-14 Aug-15 May-17 Mar-18 Actual
have an impact on the real economy only in the short run. In
Source: AMECO; European Commission; author’s calculations
the medium run, the economy tends to return to what econo-
mists call its “natural growth rate,” which is equal to the rates
of labor force growth and technical change. These two factors growth rate estimated at the time, the Greek economy would
are assumed to be structural and independent from short- have surpassed its precrisis (2007) peak in 2017. This would
run shocks. Hence, according to this approach, the best way still be a “lost decade.” However, as we also saw in Figure 1, as
to boost an economy’s long-run prospects is through “struc- of 2019, real GDP was still nearly a quarter below its 2007 level
tural reforms” that will increase the growth rate. A lot of the and heading even lower due to the pandemic shock.
“reforms” in Greece were justified along these lines. Another consequence of the lower-than-expected eco-
A corollary to the failure of these growth rate projections nomic performance was that the public debt-to-GDP ratio pro-
is that real GDP fell much more than forecasted. Figure 8 pres- jections also proved to be overly optimistic. Figure 9 presents
ents the trajectory of real GDP together with the forecasts at the actual and projected trajectories of this ratio. It shows that,
the various stages of the three programs. It shows that—as as in the case of the growth rate and the level of real GDP, the
mentioned—the original May 2010 projection envisaged a public debt-to-GDP ratio is way above what it was expected
shallow recession. Assuming that the economy would keep to be, despite the debt restructuring that took place in 2012
growing at a rate of 2.1 percent, which was the medium-term (hence the drop in the ratio that year).7
Levy Economics Institute of Bard College 9The most accurate of the adjustment programs’ forecasts Implications for the Future
has been the primary balance. According to the original May The preceding discussion has some important implications for
2010 agreement, the primary balance was supposed to have the future. At the end of 2019, the public debt-to-GDP ratio
improved by around 12 percentage points until 2013.8 This was around 177 percent. Given these high levels of debt relative
adjustment had to take place during a recession in Greece and to GDP, even small macroeconomic shocks could have caused
Europe and amidst a fragile global economic recovery after its trajectory to explode. The pandemic shock, and the ensuing
the 2007–9 crisis. The actual consolidation approached these crisis, will definitely do that. Hence, Greece faces the danger of
projected levels. If we exclude the expenditure on bank recapi- yet another round of austerity that will lead to another down-
talization, the difference between the primary deficits of 2009 ward spiral and further undermine economic and social rights
and 2013 was 12 percentage points. in the country—and healthcare provision in particular.
Fiscal deficits are usually countercyclical: they tend to To understand this, we can refer to the Debt Sustainability
increase in recessions and decrease in upswings. The reason Analysis (DSA) in the July 2018 Compliance Report, which was
for that is that certain kinds of public expenditures—such the last report of the third adjustment program that ended in
as unemployment benefits—increase during recessions, August 2018 (European Commission 2018a, 41–3). Since the
while tax revenues decrease since taxable income decreases. end of the third adjustment program, Greece has been under
Therefore, given the drop in output that took place over the an “enhanced surveillance” status and Enhanced Surveillance
same period, the fiscal consolidation that took place in Greece Reports have been regularly published. The July 2018 DSA
is extraordinary. forms the basis of the DSA in the more recent reports and their
The prioritization of fiscal consolidation over other policy results are broadly similar.10
targets is crucial to understanding the evolution of the Greek The underlying assumptions of the July 2018 DSA are the
crisis (and has important implications for the future, which following:
will be discussed in the next section). A basic characteristic
of the Greek programs is that the fiscal targets are incompat- 1) Short-term real GDP growth follows the Commission’s
ible with the growth targets. The austerity put forward in the (then) latest forecast (around 2 percent until 2020).
first program had much more severe effects on GDP than those 2) Long-term real GDP growth is 1 percent after 2022.
officially projected.9 At the same time, these effects also had a 3) Inflation gradually rises from 0.9 percent in 2018 to 2 per-
negative impact on the government’s fiscal position through cent in 2023 and maintains that level thereafter (hence,
the automatic stabilizers (higher unemployment benefits, nominal growth is 3 percent over the long run).
lower tax collection, etc.). The prioritization of fiscal targets 4) Total privatization revenues are around €14 billion
meant that new fiscal measures had to be adopted (lower gov- between 2018 and 2060.
ernment expenditures, higher taxes) to compensate for the 5) The government’s primary surplus is 3.5 percent of GDP
worsening fiscal position. In turn, these new measures led to a until 2022, and then decreases 0.5 percentage points per
further decline in economic activity, further undermined the year, reaching 2.2 percent of GDP in 2025 and remaining
targeted fiscal balance, and eventually necessitated the adop- there afterward.
tion of even more fiscal measures. In addition, the depressed 6) Market interest rates follow the expected risk-free rate plus
economic activity had a very adverse effect on the banking a risk premium; they are expected to reach 4.1 percent in
sector. As a result, Greek banks—which had been otherwise 2019, and then gradually increase to 5.4 percent by 2030,
quite conservative before the 2007 crisis—needed two rounds ending up at 5.1 percent in 2060.
of recapitalization. 7) Part of the Greek government’s available cash reserves will
This was the vicious cycle between austerity and recession be used to cover its debt (bringing its cash balance down
that led to the collapse in output (Figures 1 and 8), which was to €12 billion by 2022).
accompanied by a similar collapse in government expendi-
ture—as demonstrated in the discussion around Figure 2— Under these assumptions, the debt-to-GDP ratio was pro-
and an increase in the tax burden (Figure 3). jected to decrease to 136.6 percent in 2030, to 125 percent in
Public Policy Brief, No. 151 102050, and then eventually to converge to 127 percent by the end with these minor changes the debt trajectory is radically differ-
of the projection period in 2060 (see Figure 10). This is still a ent compared to the baseline, and debt explodes.
high level of debt, but represents a declining trajectory. Even before the pandemic shock, the sensitivity of these
Another commonly used measure of debt sustainability debt sustainability projections to even minor deviations
is gross financing needs (GFN), defined as the sum of budget from the optimistic baseline assumption was worrisome. To
deficits and funds required to roll over debt that matures in the a certain extent, it looked like the baseline assumptions were
course of the year. Debt sustainability requires GFN to remain calibrated in such a way to make the debt appear sustainable.
below 20 percent of GDP. Under the baseline projections, this These considerations led the IMF to abstain from the third set
is also the case. Hence, under both measures, the debt is con- of adjustment programs, as according to their own DSA the
sidered sustainable. Greek public debt was not sustainable, even in their baseline
Besides the baseline scenario, the report simulates an calculations (see, for example, IMF [2016]).
“adverse scenario,” which is particularly interesting. Under There are several reasons why the baseline assumptions in
this scenario: the European Commission’s DSA are unrealistic. A permanent
1) Between 2023 and 2060, nominal GDP growth is reduced primary surplus of 2.5 percent is far above the Greek historical
by 0.2 percentage points per year compared to the baseline experience. It also implies a permanent improvement in the
scenario (that is long-run nominal growth of 2.8 percent trade balance, and at the moment it is not clear how this would
as opposed to 3 percent in the baseline). come about.11 Similarly, it is also not clear how the inflation
2) The primary surplus follows the baseline path until 2022 rate will converge to 2 percent so quickly. This is in line with
and then decreases to 1.5 percent in 2023 and afterward. the European Commission’s modeling assumptions (where
3) The rest of the assumptions remain unchanged. everything converges to some sort of “natural” level in the
In this adverse scenario, debt explodes after 2032 and reaches medium run), but it is very questionable as to whether it will
235 percent of GDP in 2060. Similarly, GFN exceeds the thresh- materialize. Inflation in the eurozone over the last decade has
old of 20 percent after 2033 and exceeds 50 percent by 2060. consistently undershot official projections.12 Finally, economic
The results of the “adverse” scenario are important growth in Europe and all around the world had slowed down
because the scenario is not that adverse: long-run nominal and a global recession is becoming more and more likely (even
growth is only 0.2 percent below the baseline and the primary without the pandemic shock). Such a global slowdown would
surplus is only 1 percent below the baseline. Nevertheless, even certainly impact the Greek economy as well.
The pandemic shock, besides its immediate effect on GDP
growth, will clearly push the debt-to-GDP ratio off track. If
we assume that, due to the pandemic, Greece’s 2020 GDP will
Figure 10 European Commission’s July 2018 Main Debt
fall by 10 percent and the primary deficit will exceed 5 per-
Sustainability Analysis Results (percent of GDP)
cent of GDP (these projections are probably on the optimistic
260
side), the overall debt-to-GDP ratio will climb toward 200 per-
240
cent. According to the European Commission’s latest projec-
220
tions—available in the AMECO database—the debt-to-GDP
200
ratio in 2020 will be 196.4 percent, while in its April 2020 Fiscal
180
Monitor, the IMF is projecting 200.7 percent (IMF 2020b).
160
Thus, Greece and the eurozone will soon face the same
140
questions they faced ten years ago. When the dust settles it
120
will become clear that Greek debt is not sustainable. What
100
will be the answer to these questions? If meeting the fiscal tar-
19
20
30
40
50
60
20
20
20
20
20
20
Adverse Scenario
gets remains the priority for Greece’s international lenders, it
Baseline Scenario is very likely that there will be a repetition of the aforemen-
Source: European Commission (2018) tioned vicious cycle of recession and austerity—further fiscal
Levy Economics Institute of Bard College 11contraction, which will trigger further drops in the level of 50 percent in 2014—was part of the wider fiscal consolidation
economic activity and employment. In such a scenario, fiscal that occurred over the same period.
expenditure on healthcare will most likely be on the menu of It was explained that fiscal austerity has been justified
cuts, as it has been in the recent past. More broadly, another as the means to achieve debt sustainability. The underlying
round of austerity will increase poverty and undermine social assumption has been that austerity does not have significant
and economic rights, much as it has done in the last ten years. effects on economic activity. Hence, the decreases in fiscal
For that reason—and as was explained in Nikiforos, Zezza, deficits will eventually lead to the stabilization and eventual
and Papadimitriou (2015)—a restructuring of the Greek debt decrease in the public debt-to-GDP ratio.
will be necessary one way or another. A continuation of aus- Things turned out differently. The fiscal targets were
terity cannot be justified on either moral or practical grounds. incompatible with the programs’ growth targets. The
Moreover, the recovery from the current pandemic depression attempted decreases in fiscal deficits led to a sharp decrease in
in Greece and most other European countries will require demand and increases in unemployment; this, in turn, tended
some form of debt mutualization, so that the debt burden due to increase fiscal deficits. Over the course of the programs’
to the depression does not push these countries into another implementation, the target that was most closely met was the
vicious cycle of recession and austerity. Finally, in the medium achievement of the primary surpluses. This prioritization of
run the eurozone will also need to take steps to address its fiscal targets led to a vicious cycle of recession and austerity.
structural imbalances. At the same time, the insistence on meeting fiscal targets has
Many would counter that these measures seem politically important implications for the future. Because of Greece’s high
unrealistic at this point. This might be true, but at the same level of public debt, the sustainability of that debt is very sensitive
time they are necessary preconditions for the long-run sur- to even minor macroeconomic shocks. The current pandemic
vival of the eurozone. shock and its impact on the government deficit and growth will
At the time of writing this brief, the European Commission make it obvious that Greek debt is unsustainable. If international
put forward a plan called “Next Generation EU,” which would lenders persist in chasing fiscal targets, the likelihood of fur-
allow the Commission to borrow €750 billion in the financial ther cuts to fiscal expenditure in general, and to expenditure on
markets and then provide €500 billion in grants and €250 bil- healthcare and social provisions in particular, is high.
lion in loans for the eurozone economies’ recovery from the Thus, the pandemic shock brings the necessity of a bold
pandemic crisis. According to initial reports, Greece would restructuring of the Greek public debt back to the fore, as well
receive roughly €22 billion in grants and €10 billion in loans. as policies that will tackle the eurozone’s structural imbalances.
This plan—if it is adopted without being watered down in
the process and if these funds are not associated with explicit
or implicit conditionalities—is a significant step in the right Notes
direction. It is also an example of a policy initiative that would 1. In 2009, social protection accounted for 34.5 percent of
have seemed unthinkable even very recently. Nevertheless, as total expenditure. By 2018, its share had increased to 40.5
previously emphasized, these kinds of measures need to be percent.
further expanded and made permanent. 2. In 2009, general public services and healthcare accounted
for 22.3 percent and 12.6 percent, respectively. By 2018,
they had fallen to 17.7 percent and 10.6 percent.
Concluding Remarks 3. The various documents from which the data were
The present policy brief discussed Greece’s recent experi- collected can be found on the European Commission
ence with austerity and the likely future implications of the website’s page “Financial assistance to Greece”: https://
policy framework that is currently being implemented. It was ec.europa.eu/info/business-economy-euro/economic-
shown that the years after the beginning of the first adjust- and-fiscal-policy-coordination/eu-financial-assistance/
ment program saw a dramatic decrease in government spend- which-eu-countries-have-received-assistance/financial-
ing on healthcare expenditure. This decrease—which reached assistance-greece_en#first-programme-for-greece
Public Policy Brief, No. 151 124. The exception to this overoptimism was the August 2015 References
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upwards) and the 2013 deficit would be 3.2 percent. Other Determinants of Post-WWII US Government
9. We have provided detailed discussions of several aspects Debt/GDP Dynamics.” American Economic Journal:
of this process in various Levy Institute policy reports on Macroeconomics 3(3): 192–214.
Greece (see, for example, Papadimitriou, Nikiforos, and IMF (International Monetary Fund) 2016. “Greece: Preliminary
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published: in November 2018, February 2019, June 2019, Washington, DC: International Monetary Fund.
November 2019, and February 2020. They can all be found _____. 2020a. World Economic Outlook, April 2020: The Great
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financial balances of the three institutional sectors of the Lewis, W. A. 1954. “Economic Development with Unlimited
economy need to sum to zero. Assuming the balance of Supplies of Labour.” Manchester School 22(2): 139–91.
the private sector does not change, this identity implies Nikiforos, M., D. B. Papadimitriou, and G. Zezza. 2015. “The
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Public Policy Brief, No. 151 14About the Author
michalis nikiforos is a research scholar working in the State of the US and World Economies
program. He works on the Institute’s stock-flow consistent macroeconomic model for the US econ-
omy and contributed to the recent construction of a similar model for Greece. He has coauthored
several policy reports on the prospects of the US and European economies.
His research interests include macroeconomic theory and policy, the distribution of income,
the theory of economic fluctuations, political economy, and the economics of monetary union.
He has published papers in the Cambridge Journal of Economics, the Journal of Post Keynesian
Economics,the Review of Radical Political Economics, the Review of Keynesian Economics,and
Metroeconomica; various other papers have appeared in the Levy Economics Institute Working
Paper Series.
Nikiforos holds a BA in economics and an M.Sc. in economic theory from the Athens
University of Economics and Business, and an M.Phil. and a Ph.D. in economics from the New
School for Social Research.
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